Silver Lake Breakup Rules Make Ending Dell Bid Costly

Dell’s stock fell below the original $13.65-a-share offer on April 19 amid speculation that the deal might unravel after Blackstone Group LP abandoned its counteroffer, citing “the rapidly eroding financial profile of Dell” and greater weakness in the PC market than the company is projecting. Photographer: Sam Hodgson/Bloomberg

April 22 (Bloomberg) -- Silver Lake Management LLC and
Michael Dell attached such stringent conditions to their Dell
Inc. buyout proposal that they may have little choice but to
stick with the deal even as the personal-computer industry
contracts at a faster-than-predicted pace.

Walking away from the $24.4 billion leveraged buyout means
the Silver Lake-led group would have to pay as much as $750
million to extricate itself, according to the merger agreement.
The terms also let Dell sue the group to force it to complete
the transaction.

Dell’s stock fell below the original $13.65-a-share offer
on April 19 amid speculation that the deal might unravel after
Blackstone Group LP abandoned its counteroffer, citing “the
rapidly eroding financial profile of Dell” and greater weakness
in the PC market than the company is projecting. Still, the
Silver Lake-led group will probably stick with its plan, rather
than subject itself to financial penalties, said Erik Gordon, a
professor at the Ross School of Business at the University of
Michigan in Ann Arbor.

“Silver Lake is in a corner,” Gordon said. The provision
allowing the company to sue is “a gun to Silver Lake’s head. If
it wants to back out, it will have to negotiate a settlement
that makes the company happy or close the deal,” he said.

When CEO Dell and Silver Lake began buyout discussions last
year, the PC maker predicted operating income of $5.6 billion
for the fiscal year through January 2014, according to a March
29 filing. That forecast was reduced to $3 billion after three
revisions and a record drop in PC shipments during the first
quarter.

Deal Terms

Neither Silver Lake nor the banks financing the buyout --
Barclays Plc, Bank of America Corp., Royal Bank of Canada and
Credit Suisse Group AG -- have expressed a desire to get out of
the deal after Blackstone pulled out April 19, said a person
with knowledge of the matter who declined to be identified
because the information is private.

David Frink, a spokesman for Dell, declined to comment. A
spokesman for Menlo Park, California-based Silver Lake had no
immediate comment. Dell said in a filing April 19 that it
continued to support the agreement with Silver Lake and expected
the deal to close by the end of the fiscal second quarter, which
ends in July.

Chief Executive Officer Michael Dell and Silver Lake agreed
to the restrictions, which also included limits on their ability
to match bids for Dell, in order to create a deal that would
withstand shareholder scrutiny, people familiar with the matter
said after the agreement was announced Feb. 5. The breakup fee
is also higher than normal, said the people, who asked not to be
identified because the talks were private.

Silver Lake

Under the terms, the Silver Lake-led group agreed to pay
the company $250 million if it withdraws the offer because of
changes in tax law, or if other legal obstacles emerge. The
higher $750 million penalty applies if the group simply backs
out, breaching the agreement.

Unforeseeable developments that would be considered a
“material adverse effect,” such as representations turning out
not to be true, could also let Silver Lake and CEO Dell pull out
of the agreement with fewer or no penalties. Any dispute taken
to court would probably result in a deal, according to Barbara
Black, a law professor at Columbia University in New York.

“A court could order Silver Lake to complete the deal
rather than just forcing the private-equity fund to pay Dell
damages,” Black said in an interview.

Silver Lake came close to walking away in January, during a
stalemate that wasn’t resolved until it increased its final
offer by 5 cents a share.

PC Slump

“If Silver Lake closes the deal, it has time to address
its problems if the deal turns out to be a bad deal,” Gordon
said. “If Silver Lake balks, it has a problem, today, and
probably kisses a couple of hundred million dollars goodbye.”

Research firm IDC released data earlier this month showing
that PC shipments plummeted 14 percent in the first quarter, a
faster pace than its projection for a 7.7 percent decline, as
demand dropped in every region of the world. The slump comes as
consumers shun PCs in favor of smartphones and tablets to check
e-mail, browse the Web and watch television and movies.

Blackstone had offered to pay at least $14.25 a share to
current Dell investors with an option to hold onto some of their
stake through a so-called equity stub.

Logical Investor

Blackstone pulled its offer after deciding that Dell’s plan
to expand share in the $3 trillion enterprise-computing market
was still years away, a person familiar with the matter said
last week. Profits from new products weren’t going to be
generated fast enough as the PC business deteriorated, said one
of the people, who declined to be identified because the details
were private.

“The PC problem is just the start of it,” said
Tripatinder Chowdhry, an analyst at Global Equities Research in
San Francisco. “Enterprise servers are going to get hit, too.”

Shares of Round Rock, Texas-based Dell fell 1.2 percent to
$13.24 at the close in New York, 3 percent less than the
original deal price.

Before Blackstone dropped its bid, the stock had been
trading at a premium to the offer on speculation that a bidding
war would erupt after Blackstone and billionaire investor Carl
Icahn proposed higher offers. Dell’s largest outside
shareholders including Southeastern Asset Management and T. Rowe
Price Group Inc. also opposed the original bid as being too low.

“Blackstone was viewed as a more logical investor to
follow through with this deal, so with them gone, the prospect
of a bidding war is also gone,” said Rich Kugele, an analyst at
Needham & Co. in Boston who has a hold rating on the shares.

Icahn’s Proposal

Blackstone’s exit also followed reports that International
Business Machines Corp. is in talks to sell its low-end server
division to Lenovo Group Ltd. Servers have been a bright spot
for Dell, posting 18 percent sales growth in the latest quarter.

Dave Johnson, one of the Blackstone executives overseeing
the firm’s bid, joined the buyout group in January from Dell,
where he led mergers and acquisitions for almost four years.
Before that, he served in a similar role at IBM, making him
uniquely qualified to assess the risks and rewards involved in a
proposal to buy the PC maker.

Even if Silver Lake remains committed, Michael Dell and the
private-equity firm will have to deflect a rival proposal by
Icahn, who has offered to pay $15 a share in cash for as much as
58 percent of Dell’s stock. The company has said that Icahn’s
proposed offer could be superior to the Silver Lake group’s deal
for all of the company.

Proxy Fight

Dell said April 16 that Icahn had agreed not to amass more
than a 10 percent stake in the company, or to join with other
shareholders to build more than a 15 percent holding.

Icahn said he’s retaining the right to start a proxy fight
and seek to replace Dell’s directors with his own candidates.
That’s not likely to happen until after a vote by shareholders
at an annual meeting, which hasn’t yet been scheduled yet. A
majority shareholder vote in favor of the deal, excluding
Michael Dell’s 15.6 percent stake, is required for approval of
the joint offer with Silver Lake, according to the agreement.